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Outcome-based outsourcing is the holy grail of IT services. Both customers and providers agree that if they can figure out a way to tie sourcing strategy to business results everyone will be happier in the end.

The problem with many traditional outsourcing arrangements is that they focus on input rather than output. Just as U.S. health care reform advocates criticize a system that incents doctors to perform tests and procedures with few rewards for the ultimate goal–a healthy patient, some outsourcing reformers say too many IT services deals are myopically focused on tasks or man-hours rather than business results.

Outcome-based contracts–at least, in theory–can change that. “Paying for outcomes is the idea of paying for success toward a desired result instead of paying for individual items like servers or programming hours,” says Adam Strichman, an independent outsourcing consultant based in Mechanicsville, Va. “Nobody really wants servers, or switches or a mainframe. They generally want a business outcome, such as faster access to information or an automated delivery system.”

But devising outcome-based outsourcing deals that satisfy both the customer and the vendor has proven difficult. Time-and-materials contracts remain the most common outsourcing model in the industry, particularly offshore, says Sandeep Karoor, managing director of outsourcing consultancy Neo Advisory. Fixed-price contracts run a distant second. Outcome-based contracts account for, at most, 15 percent of new deals, says Strichman, and they may only apply to part of the outsourced work.

Who’s Outcome Is It Anyway?

Part of the problem with this new paradigm, whereby contracts are based on results rather than resource consumption, is in defining outcomes. Every stakeholder has a different desired end state–or two or three. The CEO wants happy customers and shareholders or to be the industry leader. The CFO wants an increase in profitability. The business unit leader may desire best-of-breed systems. And the CIO? He’s got a whole list–lower costs, better service levels, increased customer satisfaction.

What may be the biggest problem of all is that the IT service provider has very little control over or connection to any of those outcomes.

Outcome-Based Outsourcing: Pros and Cons

Pros

* More cohesion of work being delivered

* Freedom from interviewing and monitoring individual staff members

* Ability to incent more innovative behavior from provider

* Potential for higher eventual savings as labor arbitrage is replaced by productivity and synergies between tasks as key savings drivers

Cons

* Lack of transparency into how work is being performed

* Little insight into costs of service (unless visibility into resource consumption is maintained)

* Additional administrative burdens associated with root cause analysis (if service is not being delivered as promised) and evaluation of service delivery from outcome-based perspective

–Source: Forrester Research

“The measure of success–or outcome–has to be directly related to the success or failure of the underlying services,” says Strichman. “It sounds simple, but it can be hard when you start talking about business outcomes. The supplier cannot influence things beyond the supplier’s realm of responsibility.”

For example, the CFO may want to tie the outsourced application development of a new product to the profitability of that new product, but that may be impossible. The application development provider could design the world’s best system two weeks ahead of schedule and a million dollars under budget, but it has little control over other factors–such as marketing, economic conditions, bad management, inept delivery managers, bad press–that affect the profit outcome.

“There are all types of outcome-based pricing,” says Strichman. “Sometimes these models have moderate success. Often they have no success whatsoever.”

The most common business outcome tied to IT services deals to date is increased customer satisfaction, says Strichman, but that may encourage the vendor to construct customer surveys that will deliver the desired result.

“The belief is that by tying metrics and pricing to the success of the business, both parties now have their goals in alignment,” says Strichman. “But the reality is, alignment is not enough; the vendor must be able to influence a significant portion of the costs which influence the outcome being measured. And the metrics must make sense related to the service. Customer satisfaction may have nothing to do with the vendor.”

Contracts focused on desired outcomes at the CIO level have a concrete record of success. With these types of deals, a vendor takes responsibility for “end-to-end” IT service levels. “The vendor is responsible to create an entire system–design, infrastructure, network, programming, maintenance and customer support/help,” says Strichman. “These contracts are not uncommon and can work. But even that is really, really hard to do.”

Resistance on Both Sides

Beyond the ability to identify and connect business outcomes to IT services delivery, another roadblock on the journey to outcome-based outsourcing is cultural resistance–from both the client and the vendor.

Customers often are not comfortable ceding the level of day-to-day control necessary to enable the vendor to focus on outcome, rather than service delivery. “Considerable change management is required in the client’s mindset during the initial delivery phases,” says Karoor.

Handing over the reins requires that the client has enough self-knowledge to be able to create realistic outcome-focused SLAs, not to mention a deep level of trust in its vendor. While Gartner has noted that providers are moving toward output-based pricing models where services support a process with measurable outcomes, buyers for the most part still seek out the safety of traditional outsourcing models. Only more mature clients are beginning to link outsourcing outcomes to business objectives, says Gartner, which “typically involves an evolved pricing model developed after relationships and trust have been established.”

Providers may resist business-outcome focused contracts because of the risk they represent. Although moving away from input-based pricing enables vendors to deliver IT services as they see fit, “the vendor assumes much more risk for the relative freedom of choice [it gets] regarding the means for implementation,” says Strichman. Indeed, the higher up the outcome on the business value chain, the more risk the provider assumes.

The trick to outcome-based outsourcing, says Fox, is “linking contractually guaranteed work by the vendor to measurable client business outcomes, such as improving product line revenue, raising customer satisfaction, increasing product innovations or reducing time to market.”

For customers who want to align vendor goals with business goals, outcome-based pricing can be the differentiator, says Fox. But not everyone is into the idea. “Some clients opt out of our outcome certainty-based contracts because they want the most simplified approach to managing their outsourcing partner,” says Fox. Those customers sign more traditional fixed-cost or time-and-materials contracts.

Some customers shied away from the strategically focused outcome-based approach to sourcing during the recession when all eyes were on cost-cutting, according to Forrester Research principal analyst Bill Martorelli. Just 24 percent of outsourcing customers said increasing their use of output-based pricing was a high or critical priority, according to a Forrester survey conducted during the second quarter of this year. Nearly one-fourth (24 percent) said it was a low priority, while 37 percent reported that it was not on the agenda. But Martorelli predicts outsourcing customers’ interest in outcome-based outsourcing will increase as the economy stabilizes.